MARKET UPDATE BLOG

Navigating Capital Gains

June 12, 2013

Surviving the gauntlet that is the federal tax code is never an easy task. In the second installment of our guest contributor series, CPA/CFP Larry Wood sheds some light on how to minimize capital gains damage with two key considerations: holding periods and investor status.

Holding Periods

For individuals, gains from the sale of capital assets such as stocks, bonds, or real estate are generally taxed more favorably than gains obtained from the sale of an ordinary asset. Seems pretty straight forward right? Here’s the tricky part: short-term capital gains—resulting from sales of properties held for a year or less—are taxed at a higher rate. The crucial question here in reducing your capital gains tax is the holding period. Capital gains are not taxed until the assets have been sold. So no matter how much your property may have appreciated, capital gains tax is not imposed until the gains have been realized from a sale or exchange.

Here are a couple of general strategies to minimize your tax from capital gains: Hold investments for over a year before selling them, and consider selling investments with capital losses to offset your gains. Capital gains are generally defined as the excess of the sales price of the investment over its basis—the purchase price, plus associated purchase costs. Basis is determined by how the investment was acquired. For instance, if you:

  •  Purchased the investment, then the basis is what it cost you.
  •  Received the investment as a gift, then the basis is the cost of the investment paid by the one you received it from, unless the investment was worth less than the original price when it was given to you.
  •  Inherited the investment, the basis is the value of the investment on the date that the person you inherited it from died.

Dealers vs Investors

If your business is dealing in land or stocks, for instance, these assets are not considered capital gains property. They are ordinary income tax property. There have been many tax cases dealing with whether someone’s activity is that of a business or of an investor to qualify the profits as eligible for capital gains treatment.

Since the economy has declined some taxpayers are now arguing that they are in the business of dealing in property and are not investors. Why? Because property values have declined and capital losses are generally much less tax-attractive than ordinary losses. After offsetting any capital gains, capital losses can only be deducted against ordinary income up to $3,000 per year (with a carryover of the excess to future years). Ordinary losses, on the other hand, can offset ordinary income without limitation.

This dealer versus investor status is not just a choice. It really depends on what you do with the assets and, sometimes, your intent. Investors are generally those who have limited transactions for their own purposes, whereas dealers regularly buy and sell assets to customers in the ordinary course of business.

Capital Gains Tax Rates Today

Gains from the sale of capital assets held for longer than a year are still taxed at a maximum rate of 15 percent for many taxpayers. However, for tax years beginning after 2012, a new 20 percent tax rate will apply to dividends and long-term capital gains for married taxpayers with taxable incomes exceeding $450,000 ($400,000 for single taxpayers) to the extent these gains and/or dividends exceed these thresholds. For taxpayers between the 25 percent and 39.6 percent brackets, capital gains and dividends will continue to be taxed at 15 percent, while the lower bracket individuals will still enjoy a zero percent tax rate.

To fully understand how these new laws may be relevant to your bottom line, please contact Larry Wood, CPA/CFP and Partner at D | Z | H Phillips, one of the most competent and prestigious accounting firms on the west coast. Larry brings a wide breadth of experience to the table, with a particular emphasis on estate and income tax planning.